On April 19, 2012, the US Federal Reserve Board ("the Federal Reserve") announced that entities subject to Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the so-called "Volcker Rule") will have until at least July 21, 2014 to bring their activities and investments into compliance with the restrictions and prohibitions of this provision of Dodd-Frank.  The Volcker Rule generally imposes restrictions on the ability of a covered banking entity to engage in proprietary trading, or to have certain types of interests in, or relationships with, hedge funds or private equity funds.

In making this much-anticipated announcement, the Federal Reserve, in coordination with the other federal agencies administering the Volcker Rule -- the Commodity Futures Trading Commission, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Securities and Exchange Commission --  sought to clarify that entities subject to the Volcker Rule will have a conformance period of two years from the statutory effective date (July 21, 2012), unless that period is extended by the Federal Reserve.  (The Federal Reserve also clarified the conformance period for nonbank financial companies designated by the Financial Stability Oversight Council for supervision by the Federal Reserve. Such companies will have two years from the date upon which they become subject to Federal Reserve supervision within which to comply with any applicable aspects of the Volcker Rule.)

During the conformance period, the Federal Reserve said that it expects banking entities subject to the Volcker Rule to undertake good-faith planning efforts, appropriate for each bank's activities and investments, to enable compliance with the Volcker Rule by no later than the end of the conformance period. Such efforts should include evaluating the extent to which a banking entity is engaged in activities and investments that are covered by the Volcker Rule, and developing and implementing a conformance plan that is as specific as possible with respect to how the banking entity will come into compliance by the end of the conformance period. The Federal Reserve also noted that planning efforts may also include complying with reporting or recordkeeping requirements, if such requirements are included in the final rules implementing the Volcker Rule and the relevant agencies determine these sorts of actions are required during the conformance period.

Observations and Outlook

While the Volcker Rule is one of the signature elements of Dodd-Frank, the initial phases of rulemaking to implement the Volcker Rule have generated substantial comment and criticism from a wide cross-section of the financial services sector in the US and globally. Indeed, the Federal Reserve, the Federal Deposit Insurance Commission, the Office of the Comptroller of the Currency, and the Securities and Exchange Commission received approximately 17,000 comment letters in response to their October 2011 joint notice of proposed rulemaking.  (The Commodity Futures Trading Commission issued its own substantially similar proposed rule on January 11, 2012, with comments due by April 16, 2012.)

Many of the comment letters raise strong concerns and objections to the proposed rules.  Key points of focus include the feasibility of implementing such highly complex rules, the impact on liquidity and risk-management for affected banking entities and funds, the impact of the ban on proprietary trading on market making, and the potential for the cost burdens of compliance to cause the relocation of financial firms from the US to locations with less burdensome regulatory regimes.

Given the volume and nature of the comments received, several of the agencies charged with implementing the Volcker Rule have already indicated that they will likely fail to meet the July 21, 2012 deadline set by Dodd-Frank for the issuance of final implementation rules.  Indeed, several commentators and some Members of Congress assert that the regulators should return to the drawing board and re-propose Volcker Rule regulations that are more easily understandable and enforceable.  While it remains to be seen whether the regulators will pursue this option, Dodd-Frank authorizes the Federal Reserve, acting alone, to set the period of conformance.  Should final rules not be in place by July 21, 2012, the Federal Reserve could use this authority to further postpone the date by which entities must come into compliance with the Volcker Rule, beyond July 21, 2014. (The Federal Reserve is authorized to extend the conformance period for up to three additional one year extensions if it determines that such an extension is consistent with the purposes of the Volcker Rule and would not be detrimental to the public interest.)

Notwithstanding any re-proposal of the Volcker Rule or the potential for additional extensions to the conformance period, the Federal Reserve's clarification that covered banking entities have until July 21, 2014 to come into compliance is viewed by many as a positive development with benefits for both banking entities and the regulators. Banking entities will have more time to conform their activities and investments with the Volcker Rule, which is especially important because of the as yet unsettled nature of the implementing regulations. The clarification of a two-year conformance period also provides the regulators with some much-needed additional time to revisit their initial proposed rulemaking, consider the various comments and questions on that approach, and take actions to address these concerns and make the administration of the Volcker Rule less complex and easier for banks to implement.

To view the Federal Reserve's Volcker Rule Conformance Period Clarification Announcement, see http://www.federalreserve.gov/newsevents/press/bcreg/20120419a.htm